Acharya warns against systemic risk building on low rates, high liquidity

Former Reserve Bank of India (RBI) deputy governor Viral Acharya on Wednesday warned against systemic risks building up and stoking inflation, if the corporate sector fed off easy money at cheap rates and the central bank indirectly monetised government deficits.

According to the former deputy governor, the corporate bond market in India gets a boost either when foreign capital flow is robust, or temporary liquidity is created by the central bank’s indirect monetisation of government deficits through secondary market bond purchases. 

“Both are associated with the misfortune that one exposes you to external sector fragility, the second to inflation fragility," the former deputy governor said, speaking at a panel discussion on developing India’s corporate debt market. 

Acharya warned that both conditions are prevalent in India. Given India’s macro constraints, where the government is spending more relative to the Indian households’ savings, “if you go along with the global liquidity glut and simply load debt on the corporate balance sheets without fixing the macroeconomic vulnerability, this could come back to haunt us," warned Acharya.

Acharya’s views on corporate bond markets were not endorsed by the central bank when he was in office, he revealed during the panel discussion organised by the National Stock Exchange and New York University. 

His fellow panelists were Ryan Banerjee, senior economist, Bank of International Settlements, Tarun Ramadorai, Professor of Financial Economics, Imperial College London, and Ananth Narayan Professor, SP Jain Institute of Management and Research. 

Even as the corporate bond market issuance is at a record high (Rs 8.23 trillion-plus in 2020), this could thin when portfolio flows dry up, according to the former deputy governor, who had left the central bank mid-last year before completing his term.  

The tendency to borrow short-term money, taking advantage of rates falling below overnight reverse repo rate, also exposes the corporates to other risks. 

The corporates will find it difficult to roll-over their cheap finances once interest rate goes up due to rising inflation. This is an inherent risk that may show up in the medium term, and hence, this cannot be the right strategy to develop the corporate debt market. In India, where growth impulses are present with significant supply-side constraints, the liquidity creation by the central bank “starts adding to the inflation impulses”. To contain that, interest rates have to be raised. 

"I don't see how interest rates can come down unless we completely decide to sidestep inflation altogether,” said Acharya.

“The moment interest rates spike, the issuers will have a problem. This is how the non-banking financial company crisis happened in India. They borrowed for a very short time after demonetisation. There was lack of liquidity and oil prices rose in April-October 2018, and interest rates had to be raised in order to curb inflation. And lo and behold, they had to pay higher interest rates, and you know, everything came to a screeching halt," said Acharya.

Acharya was also highly critical of the recent discussions on India considering targeting a higher inflation point than the existing midpoint of 4 per cent. 

“I think those who think that it's okay for India to run 6 per cent inflation, I wish they would one day step into the poor man’s shoes. Food actually does constitute a very large part of the poor man’s daily consumption. These people seriously have to constrain their consumption basket if inflation is allowed to rise," added Acharya.